Pakistan needs structural transformation of economy: ADB

Pakistan government will need to update its investment laws, reduce burdensome regulations, align them with global best practices, and structure the investment policy document accordingly, besides, synchronise its monetary, fiscal, and trade policies to promote a business-friendly trade environment, says the Asian Development Bank (ADB).

The Bank in its report, Economic Corridor Development in Pakistan Concept, Framework, and Case Studies, stated that Pakistan’s high economic growth has been marred by quick and successive faltering episodes. To relax the balance of payment constraints on growth and sustain the high-growth episodes, Pakistan should pursue the structural transformation of its economy.

The report noted that Pakistan’s export decline is largely an outcome of low productivity and a lack of competitiveness, but an in-conducive trade policy environment also played a key role.

An overvalued exchange rate and escalation of tariffs on imported raw materials and intermediate goods could have contributed to the fall of exports, resulting in a consistently large trade deficit, which stood at $32.8 billion in fiscal year 2019.

Furthermore, exporters have often faced a liquidity crunch due to non-payment of sales tax refunds and duty drawbacks.

The increase in interest rates to 13.25percent in 2019 had substantially raised the cost of capital to firms, which may further dampen investment and exports.

The changes in tariff policy through statutory regulatory orders (SROs) may give rise to uncertainty and increase the trade transaction cost, which in turn will hurt exports and investments, it added.

The report further noted that historically, Pakistan’s monetary policy has been prone to political influence, which can crowd out private sector borrowing and investment.

The exchange rate management policy has mainly subsidised imports, which has kept the exchange rate artificially overvalued at the exporting sectors’ cost, resulting in large internal and external deficits.

Since November 2017, the defence of an overvalued exchange rate has become untenable due to declining reserves, which led to 66.9 percent devaluation against the United States (US) dollar at the peak in August 2020.

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While complete independence for the State Bank of Pakistan (SBP) and a singular focus on the interest rate and targeting inflation might not be feasible, there must be good coordination between the SBP and the fiscal policy board and operational independence for the SBP.

The government’s decision to amend the SBP Act for upholding its autonomy, mandate, and governance is a step in the right direction.

The amended act seeks to, (i) make domestic price stability as a primary objective of the monetary policy; (ii) prohibit the financing of the public sector debt; (iii) remove quasi-fiscal operations following a phase-out period; (iv) introduce statutory mechanisms to allow sufficient capitalization and profit retention; (v) secure stronger protection of the personal autonomy of senior officials; (vi) enhance roles of external auditors, the audit committee, and the internal audit function; (vii) promote mutual decision-making at the executive level; and (viii) provide stronger oversight by the board.

To fully utilise the benefits from the China-Pakistan Economic Corridor (CPEC), the study offers four policy recommendations including (i) Undertake structural reforms to unleash the potential for the private sector development.

Structural reforms to support the private sector will enhance Pakistan’s competitiveness, productivity, and access to the global market. (ii) Broaden the tax base to unleash the country’s tax revenue potential while improving the fairness of tax collection. (iii) Utilize the transport infrastructure built under CPEC effectively and efficiently to maximize investment return by converting it into a multilateral initiative. (iv) Expedite the development of the nine SEZs planned along the CPEC routes. CPEC is an opportunity for Pakistan to enhance connectivity and improve the export position.

Nonetheless, the CPEC is not a sufficient condition to improve the Pakistan economy. Necessary structural reforms like private sector development or tax reforms need to be implemented to unleash the potential brought with the CPEC, it added.

The ADB further stated that because of the poor quality and quantity of roads, railways, ports, and energy, Pakistan’s share in global trade is declining, and its share of manufacturing in GDP is shrinking. Despite recent infrastructure improvements, Pakistan ranked 122nd out of 160 economies on the World Bank’s Logistics Performance Index in 2018.

To reduce the infrastructure gaps, Pakistan can use the economic corridor development (ECD) strategy to create special economic zones (SEZs) and link them with the CPEC and the Central Asia Regional Economic Cooperation (CAREC) corridors to foster greater regional and global economic connectivity and improve transportation and logistics services.

One of the main reasons for Pakistan’s lag in manufacturing and exports is limited international market access. To improve market access and tap into new markets for manufacturing and export products, Pakistan could expand trade promotion activities such as trade fairs and exhibitions, especially for small- and medium-sized enterprises (SMEs), it added.

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Pakistan could advocate a cluster-based marketing strategy to reap economies of scale benefits such as incentives and matching grants to the SMEs to conduct international market research and develop marketing strategies.

Pakistan should improve compliance with the World Trade Organization (WTO) standards and international certification by developing national product standards, enforcing them while ensuring consumer safety; and fully leveraging digital platforms, e-commerce, and information and communication technology to attract large international players.

A shortage of technical skills has constrained the acquisition of new technologies, impeding the move into high value-added products and technology-intensive industrial activities.

This study offers several policy options to overcome the skills shortage, such as (i) restructuring governing institutions and reviewing regulations to attract private sector training providers into investing in the TVET sector; (ii) adding more industry-relevant and competency-based programs; (iii) and setting up a research fund for conducting a projection analysis of skills and occupation demand and modifying the courses offered to meet industry needs.

Vertical interventions focus on matching grants, tax offsets, infrastructure support, and seed investments in high-potential economic sectors. To identify the potential economic sectors that have hidden comparative advantage, Pakistan must follow a systematic approach such as the Growth Identification and Facilitation Framework, which allows countries to locate latent comparative advantage and leverage it to achieve structural change, and select enabling sectors that have high linkage effects, such as ICT, logistics, energy, and construction, and existing export sectors that have high prospects for global growth, the report noted.

Pakistan has mines and rich mineral resources, but these are plagued by weak exploration, policy and regulatory issues, and a lack of modern mining technology. The government must address the issues in mine management regulations so that private investors can make investment decisions based on consistent information.

On forestation, the country must establish strict policies on replanting and the sustainable use of forest wood and provide information on tree varieties that offer the most optimal return. Pakistan’s rich ocean resources provide an ample supply of fish and shrimps to meet local demand and bring great value to international markets.

The government should support the development and strict enforcement of health, safety, and food hygiene regulations and develop suitable harbours and hatcheries for natural fish resources that are used for high-value exports. In the manufacturing sector, the chemical industry is likely to drive innovation.

Despite abundant iron ore deposits, Pakistan’s local steel production has not kept pace with increasing demand for improved quality and variety. The Pakistan government could attract the PRC’s steel manufacturers given the SEZ development under the CPEC.

It must also collaborate efforts in increasing the quality of and using technology in developing plastic products and composite materials. In addition, this study has identified surgical goods, knitted garments, and bed/ table linen as the three most attractive sectors with export potential, with bovine meat also suggesting opportunities for growth.

To identify and promote industry sectors that can compete globally, it could undertake detailed mapping of economic potential across districts and design an incentive structure to promote investment in the marginalized districts.

However, Pakistan lacks the administrative machinery for managing ECD and its building blocks.

Its complex tax administration and compliance requirements impede growth and expansion of private investment; project management and implementation are weak; and a coherent regulatory framework for land use and urban development is lacking.

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